Green Mountain Coffee Roasters Needs Fixing

At the Beyers household, we've had three Keurig brewers since Christmas. Each of them has failed multiple times. The newest one, which shipped direct from Keurig less than a week ago, has already failed twice this in the past 24 hours.

Fixing the brewer isn't easy. As the Keurig reps I've dealt with over the past two months explain it to me:

First, bend a paper clip. Remove the K-Cup holder. Stick the sharp end into holes in the needles inside the machine. Rotate to remove loose grounds. Wash the cup holder. Return it to the brewer. Close it up. Try brewing pure water to cleanse the system. Repeat at least twice.

For me, jury-rigging in this manner coaxes at least one extra cup of delicious coffee out of the brewer. But if history holds, even this band-aid will fail at some point. This is our third brewer, after all.

And that's important; I'm one of many having trouble with a Keurig brewer. Higher-than-expected warranty expenses reduced Green Mountain Coffee Roasters' (Nasdaq: GMCR  ) first-quarter gross margin by 230 basis points.

The picture gets worse when you look at it in terms of real dollars:

Metric

Q1 2011

Q1 2010

Keurig division sales $345.1 million $212.0 million
Warranty reserve balance $17.7 million $1.7 million
Warranty reserve as a % of division sales 5.1% 0.8%

Source: SEC filings.

Pretty stark, eh? The rise appears to be at least partly due to a rise in the types of problems customers are experiencing. Here's how Chief Financial Officer Fran Rathke addressed the issue during the first-quarter earnings call:

"Last year, fiscal '10, starting in our fiscal Q2, we had a very different type of issue with primarily the B70 where it manifests itself very quickly. So the consumer would buy the brewer and within a week or two after using it, there was an issue with the component ... What has happened last quarter, and now much more predominantly this quarter we're seeing, is what we're calling a later-stage issue with a family of reservoir brewers, where months and months later after they own the brewer, they're -- not in a consistent way, but in some of the brewers, they're having some issues, we believe, tied to a component." [Emphasis added.]

We own the B70. All three of our machines have suffered the first issue, including the one we just received directly from Keurig. No wonder warranty reserves are through the roof. Problems with the B70 have persisted for almost a year now.

This isn't what you want to see when you're betting on a stock that, at 26 times forward earnings, is trading with huge expectations. Wall Street's target is 30% annual profit growth over the next several years. Warranty problems could get in the way of Green Mountain's growth trajectory.

Quality problems have a way of crimping growth. But don't take my word for it. Look at AT&T. The carrier has taken to discounting to keep customers frustrated with its network performance from fleeing to Verizon now that Big Red is carrying the iPhone.

Or better yet, look at Toyota (NYSE: TM  ) . Recalls have plagued the automaker even as Ford has reestablished itself as the top U.S. carmaker and in the process become a relative beacon of quality in an industry that badly needs a standard-bearer.

For Green Mountain, quality problems come at the wrong time. Starbucks (Nasdaq: SBUX  ) this week signed a deal to bring single-cup brewing to as many as 500,000 hotel rooms. Longer term, the coffee king could develop its own Keurig competitor, Smart Money reports.

I'd be among those tempted to try Starbucks' brewer if one were forthcoming, if only because I've become addicted to the single-cup style. Single-cup brewing is tasty, convenient, and I suspect cheaper. (No more wasted half-pots of coffee.)

Having said that, I'm also intent on giving Green Mountain Coffee Roasters every chance to fix its problems. Every encounter with Keurig staff has been pleasant. I've received free coffee for my trouble. Our replacement brewer was sent via priority shipping. I've detected no lack of willingness to make my experience better, only the means to do so. But a design problem is still a problem, and it needs fixing. Fast.

Now it's your turn to weigh in. Please let us know what you think about Green Mountain's warranty issues, the stock, and whether you'd buy now using the comments box below. You can also rate Green Mountain Coffee Roasters using the comments box below.

Interested in more info on the stocks mentioned in this story? Add AT&T, Ford, Green Mountain Coffee Roasters, Starbucks, Toyota Motor or Verizon Communications to your watchlist.

Ford and Starbucks are Motley Fool Stock Advisor selections. Green Mountain is a Motley Fool Rule Breakers recommendation. Motley Fool Alpha has opened a short position in Green Mountain. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool owns shares of Starbucks. The Fool is also on Twitter as @TheMotleyFool. Its disclosure policy is invaluable.


Read/Post Comments (8) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 17, 2011, at 7:01 PM, midnightmoney wrote:

    While the larger point with gmcr is not lost on me, your problems strike me as a notch down from surreal, a label I'd reserve only for the solution to your coffee fix (continuing to bother with the kuerig thing at all). You can buy a nice french press for a fraction of the cost. You won't waste coffee or water, can use whatever kind of beans you want, and you don't have to mess with such a wasteful heap of so many uncooperative metal bells and plastic whistles. Is the kuerig really actually anything more than that? Doesn't sound like it.

  • Report this Comment On February 17, 2011, at 10:16 PM, mokeary wrote:

    This article was timely. I am now waiting for my thrid Kuerig. The first lasted a month, second 11 months. Customer service is excellent. They replace without any question, but can't be making a very good profit when they have replaced two expensive machines for free.

  • Report this Comment On February 17, 2011, at 11:07 PM, ingr72 wrote:

    Of about 12 people I know only a few had problems with their machine. But because they enjoy the coffee, and variety of coffees they can use and try without buying a pound of each one. Everyone basically "LOVES GM" !!!!

    Everywhere I go I see it on display and people looking and buying GM coffee pods.

    I think today's sell off was overdone and I might become a buyer again of the stock after the long week-end.

    I still believe someone will eventually try to buy them out. My guess is Sara Lee ...

  • Report this Comment On February 18, 2011, at 8:35 AM, KnowingNothing wrote:

    French press is the same as a K-cup??? We have a press at home and i can tell you the clean up is NOT the same nor the convenience plus the waste and time to boil water.

    i have no position but will consider one if the price is right.

  • Report this Comment On February 18, 2011, at 10:25 AM, LQM2 wrote:

    For what its worth, I've had a B60 for years and never had a single problem. But its not worth much cause I'm not foolish enough to make decisions based on marketing research on myself.

    On the conference call CFO Rathke clearly identified the issue and said it was fixed. Yet your article is titled "needs fixing" like you discovered something. Your selective use of Rathke's comments shows the article is taking a biased position rather than offer complete disclosure which would be much more helpful to us as investors. But it seems your titles need to be provacative to draw eyeballs to your web ads.

    I'm not sure what you guys have against this company, but you've been negative starting with analyst Ms. Lomax 3-4 years ago. Why don't you start with some accountability and admit you've been dead wrong. Then follow up with some investor-helpful articles instead of this "read-me-now" headline crap.

  • Report this Comment On February 18, 2011, at 11:01 AM, TMFMileHigh wrote:

    @marknmpls,

    >>On the conference call CFO Rathke clearly identified the issue and said it was fixed.

    That's right, she identified *both* issues -- there are more than one -- and claimed the component has been fixed. Specifically relating to my issue:

    "And we primarily saw consumers taking those brewers back to the retailers, so we experienced, last year, much higher sales return. We then, in Q2, worked on remedying that, working with our customers as well as our retailers. In Q2, we had a large increase in our sales return reserves as well as, partially, a higher warranty rate as well. That also continued into Q3. And then we believe we had remedied that situation and we have seen that issue really go away."

    Great, except that the problem hasn't gone away.

    >>I'm not sure what you guys have against this company, but you've been negative starting with analyst Ms. Lomax 3-4 years ago.

    Please get real. I'm long GMCR in CAPS. I'm also a member of the Rule Breakers team. Green Mountain sits proudly on the RB scorecard and has for some time now.

    >>Why don't you start with some accountability and admit you've been dead wrong. Then follow up with some investor-helpful articles instead of this "read-me-now" headline crap.

    Again, get real. The warranty data is forward-looking; it represents management's view of anticipated warranty repairs. This means there's a current problem that has yet to be fully addressed.

    Either you don't understand how a warranty reserve works, or you're simply annoyed that there may be issues with this stock.

    Thanks for writing and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On February 18, 2011, at 11:15 AM, DaveGruska wrote:

    We're on our second brewer - like everyone's said, GMCR's customer service is top-notch. They sent a new, upgraded model, and this one seems to be working fine.

    IIRC, GMCR said a while ago that they got reimbursed quite a bit from the manufacturer of the brewers for some of the problems.

  • Report this Comment On February 18, 2011, at 5:18 PM, dicktheman wrote:

    I imagine a coming backlash from eco-conscious folks. Without knowing much about the packaging, this seems a very wasteful, and expensive, model that exacerbates problems with ever-filling landfills.

    My bigger issue with Green Mountain is that I've simply never enjoyed any of their coffee that I've tasted. I have the opposite view of the contributor that said you guys are unjustifiably negative on the stock. I've wondered, given my admittedly limited experience with their product, how you could have such a positive outlook.

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